Smart Money Podcast: How to Correct Roth IRA Overcontributions and Maximize Your Savings

Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions. In this episode:

Learn about fundamentals to consider before buying an individual stock and what to do if you over-contribute to a Roth IRA.

This Week in Your Money: What fundamentals should you consider before buying an individual stock? What should you do if you accidentally over-contribute to a Roth IRA? Hosts Sean Pyles and Elizabeth Ayoola discuss cautionary tales from the stock market to help you understand how to safeguard your investments. They begin with a discussion of Trump Media & Technology Group Corp (NASDAQ: DJT) and evaluate its performance since going public, then share tips and tricks on the importance of fundamental analysis, the risks of meme stock frenzy, and the value of diversification.

Today’s Money Question: Investing writer June Sham and host Sara Rathner join Sean to answer a listener’s question about Roth IRA contribution limits. They offer a detailed breakdown of Roth IRA contribution limits, strategies for dealing with over-contributions, and ways to circumvent the 6% penalty tax.

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This transcript was generated from podcast audio by an AI tool.

The fundamentals are now and will always remain the fundamentals. Especially when it comes to investing, it’s important to do your homework before investing in any stock. If you don’t, you could end up buying into something just because you like it, regardless of those fundamentals. In this episode, cautionary tales from the stock market.

Welcome to NerdWallet’s Smart Money Podcast, where we help you make smarter financial decisions, one money question at a time. I’m Sean Pyles.

And I am Elizabeth Ayoola.

This episode, we answer a listener’s question about what happens when you contribute too much to accounts like HSAs or IRAs. But first, Elizabeth, if there’s any show on earth that tries to avoid politics more than we do, I don’t know of it.

Yeah, I mean, we’re political agnostics here at NerdWallet. Politics? What’s that?

But I feel compelled to address an elephant in the investing room.

An elephant, Sean, I see what you did there.

Thank you. Thank you. I will be here all week and I do take tips. So former President Donald Trump, who is also the presumptive winning candidate for the Republican nomination this year, has a company, well, he has several companies, but this one called Trump Media went public last month.

Oh yeah, that. But yeah, it went public with the ticker symbol DJT, and it’s the parent company of his social media outlet, Truth Social.

Right. So listeners might remember when the stock debuted, it had a valuation of $8 billion. That’s billion with a B. Its stock price opened at $70 a share on March 26th and topped out at more than $79. There was a lot of hoopla around that. But then on April 1st, a filing with the Securities and Exchange Commission revealed that Truth Social had lost $58 million last year. The stock plunged more than 21% in a day.

As my son would say, womp-womp. Life came at Trump Media fast, and that was the start of what you might fairly call a rocky road for the Trump Media and Technology Group. So as if it couldn’t rain any harder for them, more recently, the company announced that it planned to issue more shares, which would dilute the current shareholder value, and the stock price plummeted again.

It has been a lackluster performance. Now, as folks know, we rarely, if ever, follow individual stock performance on the show. We’re all about index funds and ETFs and all that good stuff that should help you sleep at night. But we read a recent article in the Washington Post that provides a cautionary tale for anyone investing in individual stocks. And the big lesson here is this: do not put all your eggs in one basket.

Exactly, because the basket might tip over and now you have no eggs. Okay, a little dramatic, but you get my point. If you were too young to learn this from Enron stock back in 2001, then learn it from these investors in DJT. This story profiles several people who put their life savings into DJT stock in March only to now see their money disappearing at a rapid pace, at least on paper.

Yeah. They expressed extreme confidence in the man Donald Trump, and therefore in Trump Media and Technology Group, despite the fundamentals showing that the company might have some issues, i.e. the $58 million loss last year and only $4 million in revenue. And this is where the method of valuing a stock known as fundamental analysis is key. While there’s a lot that can go into fundamental analysis, it’s essentially about the relationship between how a company is performing and its stock price. Strong performance can mean a higher price, to put it very simply. When a company’s stock price is relatively high but its performance isn’t so hot, that’s a sign that we may have entered into meme stock territory. Now, if you want a piece of that company, nobody’s stopping you. I mean, if Cher or Lady Gaga issued a stock, I might buy some just for the novelty of it. But the caution here is against putting all of your hard-earned money in one place.

Look, Sean, I learned two new things about you, you like Cher and Lady Gaga.

Love that. All right, jumping back on the topic, yeah, guys, so don’t count on the stock market to somehow save you. Remember, the stock market is a family affair, and it’s made up of a lot of players, aka siblings, long-distance cousins, in-laws, and the long and etc. So it includes millions of individual investors who may not agree with you that your chosen company is the best thing since sliced bread. In fact, Sean, this has given me flashbacks to the meme stock craze from early 2021. Remember GameStop?

Yep. We’ve talked about that many times on this show. Stock values can be influenced in both directions up and down by people who aren’t just buying stocks, but maybe shorting them too. That means they’re betting a stock value is going to go down and they make money when it does. So without getting into all the details, again, suffice it to say do your homework before you invest in individual stocks.

And I’m going to add, just do your homework, period. So that includes before investing in mutual funds as well.

Yep. And I’m going to say it again, don’t put all your eggs, especially your nest eggs, in one basket, especially when that basket is the meme du jour. Diversify, diversify, diversify. And thus endeth the lesson.

I have big plans for retirement, and that includes traveling around the world to find the best margaritas and the best seafood pasta. No time for gambling my money, aka not diversifying.

All right, before we get into this week’s listener question, we’re going to kick off the next Nerdy question of the month for May, which is, what is your weird money habit?

Sean, honestly, I don’t have any. I’m so boringly normal.

Okay, come on, Elizabeth. There’s no way you don’t do something odd or unconventional with your money. Something you like to buy that people might be surprised about? Something that you do to make a little scratch on the side maybe? Or maybe, like one of our producers, you need to have all of your cash money in order and facing the same way in your wallet? Nothing like that at all?

Wait, what? No, Sean. No. Especially that last one. No, no. Let me tell y’all, I’m a good time when it comes to vibes, but I’m boring when it comes to money.

Well, I like to have my dollar bills facing each other so they’re giving a little kiss to each other in my wallet. I’m just kidding. I don’t carry cash at all.

Okay. I was going to say, I learned three things about you today. All right.

Well, later this week we’re going to launch a series that we’re calling Weird Money. And this is weird in all the good ways. We’re going to feature a fellow nerd who has dozens of credit cards.

Dozens. We’re also going to hear from someone who makes a living on collectibles and a woman who with a friend started couponing and turned it into a big business.

Wow. I want to know what they’re collecting, what are these collectibles? And I want to know about the bargains as well. I mean, sometimes I’m too lazy to search for them. So I think it’ll be a good episode.

Yeah, I can relate to that. And then, in our final episode of the series, we’ll talk with someone who racked up a whole lot of credit card debt and then told the whole world about it on her TikTok channel. The public accountability helped her pay all of it off. I can’t imagine putting all of my private financial information out there for the world to see, so it’s a little weird.

It’s a little weird, but it does make me think you can probably learn a lot about a person by eyeing their debit accounts or credit card statements. I’ll give y’all a hint into mine, and you might see some tarot readings in there, some payments for tarot readings, just saying.

Well, hey, whatever your financial priorities are, that is okay. So, folks, we want to hear about your weird money thing, your weird money behavior. What do you do with your finances either to spend money or make money or manage money that the rest of us might find, let’s use the word unconventional or maybe funky?

So I just want to put it out there. We do not want to hear about anything illegal. Please keep that in your diary, okay? But I am looking forward to all the things people do with their money that might be unexpected and also fun. And it might even be helpful to the rest of us, and maybe it’s going to help me be less boring with my money. Although, boring works for me. I’m a disciple of Warren Buffett.

Elizabeth, I’m wondering now if you are so financially boring that you’ve circled back around to being weird. You’re weirdly boring.

So let us know, listeners, we would love to hear your weird money habits big and small. We might just feature it on an upcoming episode.

Tell us your weird money habits by texting us or leaving a voicemail on the Nerd Hotline at 901-730-6373. That’s 901-730-NERD. Or you can email us a voice memo at [email protected].

And while you’re at it, send us your money questions too. It is our job to help you answer them. And a quick note before we get into this episode’s money question, we are running another book giveaway sweepstakes ahead of our next Nerdy Book Club episode.

Our next guest is Jake Cousineau, author of How to Adult: Personal Finance for the Real World, which offers tips to young people on how to get started with managing their money.

To enter for a chance to win our book giveaway, send an email to [email protected] with the subject of book sweepstakes during the sweepstakes period. Entries must be received by 11:59 p.m. Pacific time on May 17th. Include the following information: your first and last name, email address, zip code, and phone number. For more information, please visit our official sweepstakes rules page. All right, now let’s get into this episode’s money question segment with our co-host, Sara Rathner, after a quick break. Stay with us.

We are back and answering your money questions to help you make smarter financial decisions. This episode’s question comes from Alexandra, who emailed us a voice memo. Here it is.

I’ve got a question about Roth IRAs. Everything was going really well investing each year until this year when my wife got an unexpected raise, which was great news except that that put us into that weird medium zone where we can only put in partial funds. So what I’m trying to figure out is, one, if we went over for 2023, does that dictate what we put into our 2024 Roth IRA, or does that mean we need to make an adjustment for our 2023 Roth in order to avoid any tax issues? Thanks for the help,

To help us answer Alexandra’s question on this episode of the podcast, we’re joined by investing writer June Sham. June, welcome back to Smart Money.

Thanks so much, Sara. I’m excited to be back.

Hey, June. As listeners probably know, Roth IRAs are accounts that you can use to save for retirement with after-tax money. That is money that’s in your checking or savings account and has already been taxed. Roth IRAs are great because they allow you to have a tax-free pot of money in retirement, but this benefit does not come without some caveats, specifically around how much you can contribute to these accounts annually and income caps on who can contribute, meaning that if you earn over a certain amount, you can’t put money into a Roth IRA. So June, can you start by talking us through the income and contribution limits for Roth IRAs?

Yeah, of course. So when it comes to Roth IRA contributions, you have to consider both your filing status and your modified adjusted gross income, or MAGI, to figure out that year’s contribution limit. For example, if you’re filing taxes as single and your MAGI for 2023 was below $138,000, you can contribute the maximum amount of $6,500 into your Roth IRA for 2023, and you have until a tax filing deadline in April to do so. If you’re 50 or older, you can add another $1,000 as a catch-up contribution. If you’re filing taxes as married filing jointly, which this listener might be, your joint MAGI in 2023 had to be less than $218,000 to contribute that maximum of $6,500, or $7,500 if you’re 50 or older.

So what happens then if you make more than that, but you still want to contribute to a Roth IRA?

Once your income is above the limit, your contribution amount is reduced incrementally. And that’s what this listener is talking about when they say they can only put in partial funds. And once you make over a certain amount, your ability to contribute to Roth IRAs phase out completely and you can’t contribute directly to a Roth. For those filing as single this year, that is your MAGI was above $153,000, and for those married filing jointly, your joint MAGI couldn’t be above $228,000. For those filing as single this year, that’s if your MAGI was above $153,000, and for those married filing jointly, your joint MAGI couldn’t have been above $228,000.

So our listener’s wife has the nice problem to have, maybe, of earning too much to contribute fully to a Roth IRA, and they may have put in too much for their earnings in the 2023 tax year. So what does that mean for their finances now? Could they face penalties for over contributing to their Roth IRA? And if so, how can they get around that?

There is a 6% penalty tax on contributions that exceed the limit, and it’s applied every year to over contributions in the account. But the good news is that this isn’t the end of the world for their finances and it can be fixed. Some options include withdrawing the excess contributions and earnings or re-characterizing from a Roth IRA contribution to a traditional IRA contribution. It’s generally easier to do this re-characterization before you file, but if they’ve already filed, they can still make those withdrawals within six months and file an amended tax return. In both cases, there won’t be penalties for over contributing, but they will have to pay tax on any earnings.

The listener also asked if going over the 2023 contributions limits dictates what they can add into their Roth IRA for 2024. And so yes, another option in this case is to apply the excess contributions to future years, which would mean reducing their 2024 contribution by that extra amount. Some people might choose this option if they think their income will be lower next year, but keep in mind, you may still owe penalties if you opt to apply the excess to a future year.

So as folks have maybe gathered by this point, dealing with excess contributions can be a little bit confusing and involves a decent amount of administrative work that’s not fun to do. So if you are in this position, I recommend talking with a CPA or a financial adviser to help you sort out what your options are and how you can handle any excess contributions. I actually found myself in a similar situation with my health savings account or HSA this past year. I got a windfall last year and I decided to do the responsible thing and top off my HSA for the year, but I slightly miscalculated how much I could contribute to my HSA and ended up over contributing.

So when I went to file my taxes this year, my CPA alerted me to this little issue and I ended up having to contact the company that manages my HSA so I could reallocate the funds from last year to this year. And it took a handful of emails to sort out, it wasn’t the most fun thing to do, but I would recommend, if you do find yourself in this situation, it’s worth sorting out because a few emails are a lot less costly to you than a 6% penalty, which is what I would also be facing with an HSA.

I went through this a few years ago with a Roth IRA. Something to keep in mind in the year you get married, your household income could double or even more than double depending on the income that your spouse is making. You start filing jointly and then all of a sudden, boom, you make too much money to contribute to Roth IRAs. And I actually found, in addition to working with our CPA, who in my case also flagged the issue, I found the customer service at the brokerage where I keep my Roth IRA to be very helpful in guiding me through every step I needed to take online to withdraw the funds correctly. So that’s another person that could be in your corner when you’re going through this. And I know how phone averse people are, you don’t like to talk on the phone to customer service, but in this case it really helped ease my mind and make this a little bit more manageable.

All right, so let’s look back a little bit more broadly about Roths and income limits. And it’s a bummer that when you earn above a certain amount, you aren’t eligible to contribute to a Roth IRA. But that doesn’t mean that Roths are totally unavailable to our listener and their wife. People might be able to contribute to a Roth 401K or even a backdoor Roth. So June, can you explain what a backdoor Roth is and how it works?

Yeah, of course. So if you exceed the income limit for a Roth IRA, that doesn’t mean its tax benefits are closed off to you. Instead, you can consider doing a backdoor Roth, which is a strategy that converts funds from a traditional IRA into a Roth IRA. To do this, you first need to have a traditional IRA or open one and fund it. Then you’ll convert those funds into a Roth IRA and pay any taxes owed. One crucial thing to keep in mind though is that because traditional IRAs offer a tax deduction and Roth IRAs only take post-tax dollars, you’ll need to pay income taxes on what’s going into the Roth IRA. There’s also a pro rata rule for backdoor Roth that looks at all of your traditional IRA accounts together and determines how that conversion will be taxed.

So can you touch on that just briefly, because it is related to all of this Roth funkiness?

Yeah. So a mega backdoor Roth, which we did do a previous episode on, is for people who have a 401K plan at work that takes after tax dollars. It does that same conversion, but the difference is that it moves funds from a 401K plan into a Roth IRA or a Roth 401K plan. That is a super simplified explanation of the backdoor Roth and mega backdoor Roth because these can be very complicated. So before you take either of these on, definitely speak to a financial advisor or your plan administrator to learn about the steps and paperwork involved as well as what your tax liability might be.

And we mentioned these different types of Roth options because even if you do earn over a certain amount, you still have plenty of options to get after tax dollars or pre-tax dollars how you want them to be in a retirement account. So I would say for our listener or anyone else who’s earning too much to contribute to a Roth IRA, explore what you have available to you and try to find tax efficient ways to save for retirement. So June, is there anything else that you think people should keep in mind as they try to make the most of tax advantaged accounts without running afoul of the IRS?

Yes. So getting in trouble with the IRS can seem very daunting, but I definitely encourage people to check out the rules around tax advantage accounts after celebrating a major financial win like a salary bump or a bonus, and like Sara mentioned, even a major life change. That way you can make an informed plan on how to spend or allocate the money, or you can take steps to fix any over-contributions.

I would say in terms of things that can get you in trouble with the IRS, this falls on the continuum of maybe a nicer problem to have, but definitely something you need to address.

Yes. Well, June, thank you so much for coming on and talking with us.

Thank you so much for having me.

And that is all we have for this episode. Remember, listener, we are here for you and your money questions, so send them our way. You can contact us on the Nerd Hotline at 901-730-6373. That’s 901-730-NERD. You can also email us at [email protected]. Visit nerdwallet.com/podcast for more info on this episode. And remember to follow, rate, and review us wherever you’re getting this podcast. This episode was produced by Tess Vigeland, who also helped with editing, Sara Brink mixer our audio, and a big thank you to Nerd Wallet’s editors for all their help.

And here’s our brief disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.